Similarities

Just a quickie that caught my eye.

Financial Times headline today "European equities staged a broad-based rally on Thursday, hitting a fresh eight month high as as string of mostly well-received corporate earnings convinced investors the recent run should continue."

The term convinced and my blog last night about the word appear seem to be interchangable. Whether you're trying to convince investors or whether you're trying to make things appear to be healthy, you are actually trying to fool them. My only question is, how much longer can the situation appear to be getting better; how much longer can investors be convinced this rally has fundamental support? With the SP around the 1,000 level, it could extend to 1,100.

Exit strategy appearing?

It's late, but I wanted to throw up a couple thoughts on some comments coming from Federal Reserve Members today.

First comment was from William Dudley of the New York Fed. Mr. Dudley said, "new Fed asset purchase programs will grow its balance sheet to $2.5 trillion, which is above the peak in December."

Next we have James Bullard from the St. Louis Fed saying, "if you permanently double the money supply, you will eventually double prices. It takes time for price levels to rise."

"The Fed can never and will never shrink its balance sheet. The Fed filled a giant capital hole in the banking system with newly created (printed) money; it cannot "take back" money any more than a surgeon can give a patient a new heart then "take it back" once the patient appears to be better."

The first thing that comes to my mind is, well, so much for the Fed's exit strategy and the good ol' greenback. The bigger the Fed balance sheet grows, the longer this crisis will last. All they are trying to do is buy time for the "toxic assets" to get back to fair value. How are they going to do this? Kill the U.S. dollar and inflate the hell out of the economy. The money supply has more than doubled and as Bullard said, the Fed can't take the money back.

Bullard should have used a better choice of words. Something that stuck out to me was his comment that "the surgeon can't "take back" the heart once the patient appears to be better." Appearing to be better and actually being better are two completely different things. Appearing to be better makes me think of some type of mirage. Sort of like the mirage of wealth people around the world thought they had before asset prices started declining the past two years; or perhaps the appearance that the U.S. economy is stabilizing.

Our authorities want to make things appear to be getting better. From an operations stand point, I applaud U.S. companies for having such strong control over operations management, which is why most companies beat 2Q estimates. This is a bullish sign and a testament to those companies. The quicker companies can get their finances stabilized, the quicker the economy can reach a bottom. Unfortunately, sales in almost all sectors deteriorated sharply....not bullish.

One way that companies appeared to look strong was with the relaxation of mark-to-market rules. Rather than pricing assets at current market values, authorities think they should be priced at some fictional/historical based value. Example: I own a house that could sell for $250,000 at current market prices. I really like this house and just a few years ago it was worth over $400,000, so I think that I'll list its value as $385,000. But wait...if the house can sell for only $250,000 right now, how can I value it at $385,000? Isn't the price of any asset the amount it could be sold for in the market? That's what I thought, but apparently our authorities don't agree.

Mark-to-market mostly helps banks. If the banks balance sheets appear to be healthy, then we're on the road to recovery. What if they banks appear to be healthy, thanks to the accounting rule changes, but deep down are masking a disease? What if the banks just used the last bullet in their gun to beat 2Q estimates. Underwriting equity and debt offerings along with decreased competition (remember Lehman, Bear Stearns, Merrill Lynch?) will provide banks with nice cash flows. Now that the underwriting is going to slow down, where are the cash flows going to come from? Add to the fact gov't wants to regulate the amount of risk that the "big" banks can take.

These appearance games will continue. I think the gov't is buying the perception is reality idea. As long as things appear to be getting better, they must be getting better...right? After all, this is the age of self evidence.

Anyway, I like this quote and I find it fitting to end this blog. Good luck tomorrow.

"People do not wish to appear foolish; to avoid the appearance of foolishness, they are willing to remain actual fools."

Monday Metrics

It's been a while since I last posted. Honestly, it's summer time and while I study the markets all day, it's been a bit of a struggle to focus on writing at night. Either way, I'm back and looking to start fresh with some updated thoughts.

There is an endless number of subjects I could write about, but tonight I'd like to focus on how I'm trying to read the market. I'll start with a trading axiom, which I've grown to find very true: You can pick the direction or the timing of the market, but you'll rarely nail both.

There's four main metrics which I analyze: structural (macroeconomics, currencies, politics), psychological (investor psychology, social mood), technical and fundamental analysis. This is more from a trading point of view. If it were long-term investing the analysis would be a bit different.

1. I'm putting the least amount of emphasis on fundamental analysis. With the consumer deleveraging, rules changes (FASB 157, naked short selling), government interference (Obamacare - Healthcare nationalization, further stimulus, or any acronym for banks to swindle money from U.S. taxpayers), and it's very hard to forecast what future earnings may be and what type of growth companies will produce. It's simply too hard to attach a multiple to a stock and be confident that you'll get it correct. There will be some analysts who are spot on, and may even earn a name for themselves for a quarter or two, but that's simply due to the law of probabilities. When looking at different asset classes (mainly distressed debt, real estate) fundamental analysis plays a much bigger role.

2. Next is the structural metric. This is more of a big macro themed metric, which should always be in an investors mind, but may not be something to necessarily trade on. European banks, predominantly Eastern Europe, are on the brink of failure. Technically they are insolvent due to the fact they are so overleveraged, that many of the banks have assets which range from 4-7x greater than those countries GDP. Think about it. The banks have "assets" which are 4-7x the amount of money the entire country produces in a year. So a bailout is literally not possible...at least not economically possible.

Saying politics are playing a huge role in the markets is an understatement. Many of the rhetoric coming from Washington is a catalyst for a market move each day. With the seeming socialization of many huge sectors of the U.S. economy, politics will continue to play a larger role in determining how this market will function.

Last part of the structural metric is the most important. That is currencies. This is one market which is extremely hard, if at all possible, to manipulate. With the U.S. dollar being under constant fire and our Federal Reserve taking a weak dollar (bailouts, quantitative easing, debt issuance) stance, you have to question how long foreign investors will want to hang out to assets denominated in USD. Also, the dollar is the worlds reserve currency. We've already seen China and Brazil work a deal so that their trades will be settled in local currencies rather than dollars. This is the slow, but seems to be steady, transition away from the USD. This will have MAJOR implications over the global economy. This is a wild card that must be kept on everyones radar.

-The weakness of the dollar since the March lows has been one of the driving factors behind the market rally. This has also contributed to the doubling of oil in that time frame and the rally in commodities as well.

3. Technical analysis is better used in context rather than a catalyst. Much of technical analysis goes in hand with my last and most important metric at this time, which is psychology. Picking up on trends, resistance, and support levels, has proven to be a solid strategy to use during such tumultuous times. The only problem is that many of today's investors are using the same strategy. Like anything else in the the markets, once a trade becomes too popular and the herd starts moving in, that should be your cue to get out.

4. Last and what I currently believe to be most important is psychology. The psyche of investors right now is fragile to say the least. With markets still down around 40% from the 2007 highs and up 47% from the March low of 666, you can understand why. The government has provided drugs to act as symptoms for our disease, but I believe they are only masking the disease or kicking the can down the road. Thanks to government intervention, no one knows what's next to come from Washington. This has created a world of uncertainty and that's the one thing investors fear most.

We've had a euphoric rally in the past five months. Investors were sick of the gloom and doom, 666 seems to serve a psychological turning point (mark of the beast), second derivative data showed signs of deceleration of the downfall, and honestly, the market was just due for a bounce. Many of the biggest market bounces come in the context of a secular bear market, which is what I believe we are still in. A great earnings season (thanks to great operations management, not revenue growth or sales) has acted a major catalyst to send this market close the 1,000 level, but 980 is a huge resistance level.

I believe we are in the midst of a temporal transition which is transition from peak to trough (temperament) and emotions run highest at this point. There are not many economic data points that should send the market higher. A move to 1,100 wouldn't surprise me, but I look to get short in certain names and sectors as this rally moves on.

Without going into too much detail, I hope that provides a decent summary into how I am trying to read the markets at this time. Everyone has their own approach and I'm not trying to influence anyone one way or another, just trying to provoke thought. Hope all is well and good luck tomorrow.

Tidbits

Just wanted throw a few thoughts out there before I head to Fenway for the game. One of my best friends is back from California and a group of us are heading to the game. Should be a good game with Brad Penny hurling for the Sox.

-The dollar is getting smacked around today and is pushing equities higher, but oil is still weak after briefly breaching the $60 level. The stock market is being driven by macro factors such as commodities, currencies, and government debt auctions. Remember last summer when oil was trading in the $130+ area and pundits said it is equity positive when oil drops? Now that the markets are more macro driven, the dive from $74 to $60 in oil has coincided with the SP hitting a two month low. Coincidence? I doubt it.

-California banks are going to stop accepting the IOU's on July 10. What are the recipients of the IOU's to do with there notes if they can't put them into a bank? Sell them for less than face value to outside vendors possibly, but they'd be getting shafted. Do you think the Fed and Treasury are going to allow the banks to do this? If yes, then the California economy, which is the main component of the U.S. economy, will continue to spiral out of control; If no, then the legislators in California know that the Fed is forcing banks to accept the IOU's and therefore they know they can continue to gear the budget towards what they want rather than what is needed. That essentially puts the great Californian bailout onto the Fed's shoulders.

-"Cash on the sidelines" debate/example. Bob has $150,000 in stocks, a $500,000 house and $25,000 in cash. Bob has $300,000 mortgage and $20,000 in credit card bills. His net worth is $355,000. The stock and housing market drops 50% and Bob has to liquidate his stocks because he took on too much risk. Bob now has $100,000 (cash and stock sale proceeds) and a house worth $250,000. He still has $320,000 of debt. Now his net worth is $30,000. Do you think that money is coming back into the market anytime soon? Sounds deflationary to me.

-Goldman Sachs had a password stolen to a system that automatically traded stocks and commodities. A press release from Goldman today said that password could be used to manipulate the markets. Ummm, does that mean that Goldman could manipulate the markets themselves then? We all know this is what they do anyways so I'm just throwing it out there.

-Read a great article in the FT yesterday from Mohammed El-Erian, one of the top dogs at Pimco and widely known as a brilliant financial mind. It was about the second stimulus plan and there was two important tidbits which I'd like to share. First, is this: he says, "What is economically desirable is increasingly becoming politically infeasible; what is politically desirable may well turn out to be economically undesirable." Secondly, he says, "The global crisis is morphing again. Having already contaminated (in a sequential and cumulative manner) housing, finance, and the consumer, it is now threatening the potency and credibility of the economic policy making apparatus. As far as I can see, there are no first best policy responses that are readily available and easy to implement. Instead, the economy will continue to struggle, navigating both the adverse implications of last year's financial crisis and the unintended consequences of the experimental policy responses. Given the inevitable social-political dimensions, this story will play out well beyond the realm of the economy, policy making and markets." That's some pretty heavy stuff. As I've said from the beginning, as the social moods move into more negative territory, the recession, or what I believe will turn out to be more of a depression, will only deepen. Let's hope policy makers can pull their heads out of the sand soon.

Heading out for the game. Take care.

Dr. David Bronner

Very lucid insights and predictions by a large retirement fund CEO.

Dr. David Bronner, CEO of the Alabama Retirement Systems, the 43rd largest investment fund in America, spoke at Rotary Club on July 3. He is one of the most highly respected fund controllers in the United States.

1) Next month (July) California hits the wall financially, that will send a ripple effect across the US economy, AND over the next two years one state after the other will fall to it's knees financially as the federal government stimulus package ends by 2011. It has helped various states at different levels comparative to their economic condition. He says the stimulus package is what's been keeping the states alive for now...except for California which was in such terrible shape the stimulus package wasn't enough to really help them. "They go first" he said. Alabama would hit the wall in February of 2011, late in the game as Alabama is in better shape than other states. Bronner says Alabama might dodge the bullet if the economy revives enough by then. But, he doesn't really think things will improve enough by then to avoid a crisis. "It will be the largest economic crisis in the history of the State of Alabama." Bronner says Alabama will experience such significant shortfalls by 2011 that taxes will have to be raised substantially to avoid collapse...probably on property. And that practically all states will face a similar fate.

2) Within 120 to 150 days from now the commercial real estate market nationally begins to collapse as stores, malls, and shopping strips, and industrial plant have enough closures (store and plant) and loss of rental revenue to make them unable to pay their mortgages. They will start going into foreclosure unable to pay their mortgages in a significant way at that time creating a second wave of economic disaster starting three to four months from now.

3) Unless oil stays above $70 a barrel Russian and Mexican economics will begin to unravel as countries ("socio-economic collapse) economies require that much from oil to have an adequate revenue stream to feed their people and economies. AND, the only other big revenue stream for Mexico is illegal drugs sold in the US...so their economy will intensify their focus on selling drugs in America as a result in order to survive if oil doesn't stay above $70...he said $90 would be better for them.

4) The US economy (according to Bronner) is today like a patient in the emergency room in the process of having a heart attack. He said people tend to think of it as being in the hospital for cancer or chronic disease. Without the huge Bush stimulus, and then the huge Obama stimulus, the economy would have already flat lined...(i.e. we'd be experiencing a Great Depression style economic collapse heading toward 25% unemployment or so as the tumble would have continued and intensified at an increasing rate, with the stock market hitting around 2,000) Bronner said the depth of the crisis was greater than ANYONE realized and agrees today, after learning the extent of the crisis, that the federal government simply had to start "shoveling" money at it to prevent a true and complete collapse of our economy. He said he, at first, was mad at this shoveling of money until he learned the truth about the amount of money necessary to prevent a total collapse which he believes would have happened.

5) Inflation will not arrive for 3 to 5 years as the economy is in a deflationary stage due to the economic plummet...and will not experience inflation until people start "buying things" again, and that's going to take while! He also believes 3 to 5 years is probably the term until true economic recovery establishes in the US and world economy.

6) China must start selling their products to people in their own country and paying their workers enough to buy them. This would increase their products prices, reducing their exports (and "besides they will lose interest in having more US dollars anyway") and enabling other countries (US) to compete with them.)

7) The greatest threat to the US economy is one of around 9 world events that could heap misery on top of misfortune at exactly the wrong time. A nuclear incident with N Korea, a plague, Israel attacking Iran (oil shock), or such could still throw the US economy into a Great Depression style situation. He said the greatest risk of this is anytime from now until the world economy gets somewhat back on it's feet...in 3 to 5 years.

Not all his thoughts may play out, but it's another voice to listen to. Although his ideas are quite pessimistic, they're more realistic than 90% of the garbage in today's media.

Monday Random's

Back from a great 4th of July weekend. It doesn't get any better than spending time with family and friends while sharing a bunch of laughs in great weather. Add to that, we saw another Tiger victory (#68), possibly the best tennis match I've ever watched, in the final at Wimbeldon with Federer and Roddick, the Celtics signed a solid bench player in Rasheed Wallace and veteran Red Sox pitcher, Tim Wakefield, made his first all-star team. It's simply a great time to be a sports fan....actually it always is, but it's still great to be able to watch the careers of Woods and Federer blossom in front of our eyes.

Couple random thoughts from the capital markets/economy...

-California is now issuing IOU's to various state vendors, as lawmakers ineptly try to piece together a budget which will not send the Golden State further into bankruptcy. All I can picture is Harry and Lloyd from Dumb and Dumber, with a briefcase full of IOU's because they spent all the real cash. It sounds surreal and is quite sickening. California would be the 8th largest economy, as measured by GDP, in the world if it were an autonomous state. It now faces a $24.3 billion deficit for the new fiscal year which began July 1. I'd say that it's a pretty good leading indicator for what's to come for the rest of the states and the country as a whole. Not pretty. The most asinine news coming from this state is that the Democrats want to raise taxes to fund the budget deficit. You serious? Rather than cut wasteful government spending, let's just add more to the people's tab. Societal acrimony anyone?

-Sweden set bank deposit rates at -0.25%. That's right, -0.25%. How the hell do you entice people to save when they are getting charged to keep their money in a bank? Have the central bankers gone mad? Let's pray that this move is extremely unsuccessful so that our own central bank brainchild, Ben Bernanke, doesn't try this move at home. These Keynesian economists are really pissing me off with their radical thought process. How anyone can buy into this, I don't know, but clearly things are going to get a lot worse, globally, before things get better.

-In an interview with ABC, Vice President, Joe Biden, said,"Our administration misread how bad the economy that we inherited truly was." After that he goes on to say that talks of a second stimulus package are being discussed. Only 10% of the $787 has been spent so far. This has clearly done nothing other than put future generations deeper in debt and allocate money for pet projects for the good folks that voted for Obama. Another surreal and sickening piece of news.

-As if you can't tell, I'm not too happy/confident with the way things are going, stock market aside. It's as if many of our "leaders" are still living in some type of fantasy land. All we've been doing for years is kicking the can further down the road so that someone else has to deal with the problems. How about we man up for once and show some actual leadership. By now, people know that we are not in ordinary times. I'm not trying to turn this into a political statement, because honestly, I'm not a Republican nor am I a Democrat; I am a capitalist. I will affiliate myself with whichever party has the most viable economic policy. I believe that if a country has a healthy economy, wealth is created, the standard of living rises and social moods rise in kind. This is the way a country should be ran. Capitalism gives every man a chance to create as much wealth as he is willing to work for. It doesn't seem as if our "leaders" agree with my thoughts, but I truly believe, down deep, the majority of the American people do. When will a voice of reason emerge? Where is John Galt when you need him?